Why the BOJ will bet small on rate hikes now to avoid a bigger shock later

• Sources say the BOJ wants to avoid a 50-bp hike as it could backfire by making markets fear the bank is desperately behind the curve on inflation, instead favoring a conventional 25-bp increase with possible follow-ups in December or January
• The yen has strengthened to around 153 per dollar from a 40-year low near 164 in July, reducing pressure on the BOJ to use aggressive rate hikes to support the currency
• Dovish board members including Toichiro Asada (who dissented in June) may push for caution as the policy rate approaches the neutral range estimated at 1.1% to 2.5%, while bank lending remains healthy at 5.4% year-on-year growth in August

Bank of Japan Expected to Opt for Modest 25-Basis-Point Rate Hike

The Bank of Japan (BOJ) is widely expected to raise interest rates by 25 basis points to 1.25% at its September 17-18 meeting, despite market speculation about a larger 50-basis-point increase. Sources familiar with the central bank's thinking indicate the BOJ has little appetite for an outsized hike, preferring gradual adjustments to avoid shocking markets and households accustomed to decades of near-zero rates.

Key Considerations

The BOJ last raised rates by 50 basis points in 1989 during Japan's asset bubble peak. Current inflation pressures are significantly lower, though concerns persist about being behind the curve. The central bank is considering accelerating its hiking pace to approximately once per quarter, rather than the current twice-yearly cadence.

BOJ Governor Haruhiko Ueda stated that economic and price conditions remain roughly on track with projections, suggesting no immediate need for aggressive action. The yen's recovery to around 153 per dollar from July's 40-year low near 164 has also reduced pressure for dramatic moves.

Market Implications

Analysts warn that a 50-basis-point hike could signal desperation and ironically heighten concerns about the BOJ falling behind on inflation. Bank lending remains healthy at 5.4% year-on-year growth in August, indicating accommodative financial conditions.

The BOJ's policy rate is approaching the neutral range estimated at 1.1%-2.5%. Dovish board members, including Toichiro Asada (the sole dissenter in June) and recent appointee, advocate for caution. Pressure from U.S. Treasury Secretary and hawkish BOJ commentary have cemented rate hike expectations, though inflation risks from Middle East conflicts, tight labor markets, and import costs remain under watch.